Broomer's Blog

The Dangers of Charts

Many people in the investment industry are competitive people. Over the years, I've noticed several managers use selective information to justify their positioning and win over their audience. On the occasions when I've been clever enough to spot this, I tend to leave in a bit of a huff. All in all, I am more impressed by those seeking the truths of a situation rather than scoring points with potential clients.

Charts can be a useful tool for snake oil salesmen. In one of my earlier blogs, I set a quiz that taxes even the most experienced investment professionals. Sometimes interpreting charts is not quite as straightforward as it might appear.

In the FT the other day, there was a chart like the one below in an article warning about the extended nature of the US market. When charts begin to look like this, most seasoned investors spidey senses start to tingle.

Although the chart above suggests that market gains are accelerating, we need to note carefully the time scale. All charts end up going parabolic if steady growth is measured over a long enough time scale. It takes time for the compounding effect to begin to kick in, but boy once it does, it really begins to tell. What really matters however is the growth rate over time.

Recent market gains have been strong but the rate of gains is not without precedent. If we use a logarithmic scale, it better helps display the long term growth trends. Here it is the angle of the chart that indicates the pace of the gains. Note that the recent run is not dissimilar to that of the 2003-07 and is indeed much slower than the 1990's bull run.